There’s leverage, and then there’s leverage, according to a recent Moody’s Investors Service commercial mortgage-backed securities report.
The way Moody’s director Tad Philipp puts it, if you base loan-to-value ratios on appraisals the way the market typically does, you get an equity answer to a debt question.
Rather, Moody’s calculates loan-to-value ratios for commercial mortgage-backed security debt transactions from more of a credit perspective, as is its mission.
The ratings agency describes this “Moody’s LTV” in its report as its primary measure of balloon refinance risk.
Or, as Philipp explains, it is a way to state a loan-to-value ratio so that it reflects the possibility of getting one’s money back after five or 10 years based on historical data.
This shows that leverage has been increasing since the first quarter, and that by the end of the third quarter—unless the deal composition of the pipeline changes before Sept. 30—the average MLTV could be above 100%, or 102.1%, to be exact. It was 97.8% in 2Q.
As you might imagine, as Moody’s loan-to-value ratio goes up, so, too, does credit enhancement.
Compared to early CMBS 2.0 deals with credit enhancement of about 5.8% for tranches with Baa3 ratings, Moody’s said it expects this level to climb to around 7.3% in the third quarter.
Moody’s does note that it believes the position in the credit cycle does mitigate the risk of rising leverage, and it said the current position in the credit cycle is similar in several ways to the early 1990s.
Even at a Moody’s LTV of 102.1% as forecast for the third quarter, the leverage for the period is below what was seen at peak/2007 when it was 117%.
“Present underwriting is still generally superior to that of the market peak,” the ratings agency said.
Moody’s said it has tested how credit enhancement levels might be affected were the MLTV to get that high, and found that credit enhancement for a Baa3-rated tranche in that case would rise further into “the low to midteens.”
As Philipp and Moody’s have noted before and do again in this report, “CMBS originators’ ability to compete for loans secured by high-quality collateral waxes and wanes as conduit spreads rise and fall in response to capital markets forces.”
The report suggests that right now, “CMBS lending remains competitive for very large loans on high-quality assets, excluding CBD office and high performing malls.
“The size of such loans, often above $300 million, exceed[s] the balance sheet constraints of many portfolio lenders, even when teamed up.” Among other observations Moody’s makes about recent or upcoming trends is a forecast that the third quarter will have fewer loans backed by multiple properties.
Typically multiple properties help diversify tenants and locations, thus mitigating credit risk a bit, so a reduction in them is worth noting. The ratings agency expects rents to be stable or increase from its cyclical lows for the two largest commercial mortgage-backed securities sectors, office and retail, as recovery advances and vacancy rates drop.
It expects the retail share of collateral to decrease while the office share increases. Moody’s also anticipates that hotel, multifamily, industrial and other property types will each have shares at or below 10% in third-quarter commercial mortgage-backed securities conduit deals.